Tuesday, May 11, 2010

Bust Up the Banks

In early January, Ben Bernanke defended the Fed's handling of the recent financial crisis. The lesson he drew was simple: better regulation could have prevented it.

This is correct. Regulation could be better and smarter. Regulators could eliminate banks' intentional evasion of regulatory oversight. They could solve the too-many-cooks-in-the-kitchen problem, in which an overabundance of regulators and a lack of coordination frustrate effective supervision of the system.

But sometimes it's not enough to impose new regulations on the status quo; sometimes a bit of regulatory "creative destruction" is in order. Many of President Obama's reform proposals are good, but they don't go far enough. There are more drastic changes that can and should be imposed in the coming years, including breaking up big banks and imposing new firewalls in the financial system. There is an even more radical idea: use monetary policy to prevent speculative bubbles.

What follows is a glimpse of the possible future of finance—if policymakers and politicians recognize that confronting crises requires radical reform.